DUBAI, Sept 12 (Reuters) - Iran is hoping that radical reform of its currency market will help to stabilise the rial, which has been badly battered by Western economic sanctions, speculators and inconsistent government policy.

The rial’s unofficial rate plunged to record lows around 25,000 to the U.S. dollar this week, less than half its value a year ago, as Iranians rushed to convert their savings into hard currencies. They fear the sanctions, imposed over the country’s disputed nuclear programme, will prevent the central bank from preserving the value of the rial.

To combat the slide, authorities have proposed establishing a currency exchange that would bring together major traders and replace the small, scattered money changers which dot Iran’s cities.

The new system, if it takes effect, could be tantamount to a “managed float” of the rial in which the central bank would not fix the exchange rate but would buy and sell currency in the market to ensure the rate did not become too volatile.

“What’s important is that the price of currency is set in a transparent market and competitive environment with the supply and demand approach,” Mahmoud Dodangeh, a board member of Iran’s National Development Fund (NDF), was quoted as saying this month by the Iranian Students’ News Agency.

But the proposal has run into heavy criticism from Iran’s private sector. Businessmen argue it would do nothing to solve the country’s underlying economic problems, including double-digit inflation and near-total exclusion from the international banking system because of the Western sanctions.

Asadollah Asgaroladi, a wealthy exporter of Iranian pistachios, dried fruit and caviar, expressed doubts about the new system at a meeting last week of the Tehran Chamber of Commerce, and in subsequent media interviews.

The currency exchange “will create a new channel for corruption”, Asgaroladi told Fars news agency. “According to the information that has come out so far, it seems that most of the trades in this bourse will be on the part of the government.”

HARD CURRENCY

The rial currently trades at two key rates: the government’s official “reference” rate, at which only a limited amount of dollars is available from the central bank, and a much weaker rate determined by an unofficial market, where the vast majority of Iranians obtain their foreign currency.

In January the government tried to close the unofficial market by announcing an 8 percent devaluation of the official rate to 12,260 and saying it would stamp out black market traders.

But the move backfired by alarming ordinary Iranians and accelerating their scramble for hard currency, pushing the unofficial rate even lower. In March, authorities backtracked and said they would let unofficial trading continue.

The rial’s slide threatens to push up inflation and fuel capital flight from Iran. It has also inflamed political divisions, with legislative foes of President Mahmoud Ahmadinejad accusing his administration of foot-dragging and worsening the crisis.

“If the government had launched the currency exchange last year through the central bank, we wouldn’t be witnessing a currency shock in the market,” Gholamreza Mesbahi-Moghaddam, head of parliament’s planning and budget committee, was quoted as saying by Fars this week.

Authorities blame much of the rial’s weakness on speculators, and argue the new system would break their hold.

The exchange would be open to “certified” buyers and sellers, according to government officials quoted in Iranian media this month. Futures contracts - agreements to trade the rial at certain prices on future dates - would become available later on, letting traders lock in prices and ensuring stability.

Ordinary people in need of dollars, such as travellers and students, would buy hard currency from designated banks at prices determined by the exchange, Reza Azimi, director for monetary and fiscal policies at the Ministry of Economics, was quoted as saying by economic daily Donya-e Eqtesad.

“Currently, market factors do not determine prices,” he said. “A few people inside and outside the country have become the decision-makers.”

State media said the exchange might be launched at the end of the current Persian calendar month, or Sept. 21. The scheme seems to have replaced a previous plan, announced last month by central bank governor Mahmoud Bahmani, to devalue the official rate once again.

SCEPTICISM

It remains to be seen, however, whether the government will go ahead with the plan for the exchange in the face of technical challenges and scepticism from some in the private sector.

The NDF’s Dodangeh said authorities hoped the price of the rial on the new exchange would settle somewhere between the current unofficial and official rates.

To ensure stability, he said, the government would provide the exchange with an initial $5 billion of foreign currencies drawn from the NDF, a body which invests in infrastructure and is funded by oil revenues.

But to function effectively, the exchange will need to persuade the mass of Iranians that it is producing fair rial rates based on market supply and demand. Otherwise, people will be reluctant to use the exchange-determined rates and continue to buy and sell dollars through the black market.

“As long as there are multiple rates for the rial, they can’t establish the bourse” because there will be no confidence in the values quoted by the exchange, a Tehran money changer told Reuters by telephone, declining to be named because of the political sensitivity of the issue.

Some Iranian businessmen argue the proposed exchange would merely create a third rate alongside the official and unofficial rates, Donya-e Eqtesad reported. These businessmen speculated the unofficial rate might drop to 30,000.

Another big question is whether the supply of dollars in sanctions-hit Iran would in the long term be large enough to meet demand at the rates determined by the exchange.

At the end of last year, Iran had $106 billion of official foreign reserves, enough to cover an ample 13 months of imports of goods and services in normal times, according to the International Monetary Fund.

But those reserves may now have started falling as the economic sanctions hurt Iran’s ability to export oil and make financing its other foreign trade more costly. Analysts estimate Iran’s oil exports may have dropped by about 1 million barrels per day from roughly 2.3 million bpd last year.

Nader Habibi, an economist at the Crown Center for Middle East Studies at Brandeis University in the United States, estimated the government now had about $50 billion to $70 billion of hard currency reserves remaining.

Some Iranian members of parliament and importers, including Mesbahi-Moghaddam, told local media this week that the central bank had for the last several weeks failed to supply enough dollars to meet demand. This fuelled market speculation that the central bank might be cutting back its supply because it was concerned about a drop in its reserves.

Central bank chief Bahmani, however, insisted the official exchange rate would remain available for use by importers who needed dollars to buy essential goods.